I was a guest speaker at an event in the last couple of weeks on a completely un-related subject matter, when the audience, sensing my experience and affiliation with the pension industry accosted me with their concerns about the new guidelines regarding Voluntary Pension Contributions. My response was frank and brutal, reminiscent of a similar response I had to give about ten years ago on the subject of “margin trading” and the collapse of the Nigerian capital market. In both cases, people have lost their sense of the fundamentals of financial planning and investing and have allowed their greed to have the better of them. There is nothing wrong with the new PenCom guidelines on Voluntary Contributions – what is wrong is that a lot of employees had gotten greedy having taken advantage of a loophole that existed in the laws and now that their channel of exploitation has been closed, they are unhappy.
The truth is that the current regulations on VCAs are well aligned with the fundamental principles of pensions. If well understood and applied properly and prudently, it represents a veritable and indeed recommended product for saving, investing for the future, augmenting our retirement benefits and believe it or not – reducing our tax liability (not evading tax, but legally avoiding it). To address their concerns, I had to take them down memory lane, and build up the argument from there. I thought it was useful to share this on a much larger platform, hence the discourse that follows.
In November 2017, the National Pension Commission (PenCom) issued a Circular specifying new rules for additional voluntary contributions to Retirement Savings Accounts (RASs). The new rules require that 50% of voluntary contributions for employees covered by the PRA 2014 be treated as “contingent” and can be withdrawn once every two years, on an incremental basis, subject to the 5 Year Tax Rule (see below), while the balance of 50% can only be withdrawn at the point of retirement alongside the rest of the RSA. My audience’s reaction to the PenCom Circular was that the new rules would deter most people from making additional voluntary contributions going forward. This feeling is no doubt ill-conceived, but well rooted in the recent history of VCAs.
You see, after the review of the Pension Reform Act 2004, and the passing of the Pension Reform Act 2014, the rules for accessing VCAs changed. Under PRA 2004 and the Regulations issued before 2014, contributions to VCAs were tax deductible so long as the contributions were not withdrawn within five years of contributing.
So, if you contributed Nxx and after three years you wanted to withdraw any part of Nxx, the tax that you had avoided at the point of contribution will now be suffered on you at the point of withdrawal of that amount. In all fairness, this process worked very well from 2006 up till 2014, although it was not as popular as one would have wanted, as only very few financially astute employees who were really taking a long-term view took advantage of it.
In 2014, the laws were amended and the provision on VCAs was changed. Under the new law, only the income earned on the original contribution would be subjected to tax, if a withdrawal is made before 5 years. Clearly, this meant that all you stood to lose was a percentage of the growth on your contribution and not any part of the contribution itself. So, the greed and abuse began – employees who saw the loophole started to transfer larger sums of money from their salaries and benefits to their VCAs, immediately reducing their PAYE tax, and returning only a few weeks later to make a withdrawal of the entire amounts, preserving the entire contribution and paying the penal tax only on the amount of growth of the contribution.
They were not interested in long-term investing with their VCAs, but more interested in making a short-term gain. The system was inundated with these movements of large amounts of cash in and out of the VCAS, and to be honest since the law permitted it – the employees were legally avoiding tax, but the fundamental principles, philosophies and purpose for VCAs were discarded. It was no longer about saving to augment your retirement benefits, it was just about avoiding tax in the short-term.
My concern is that the VCA is not meant for such short-term exploitation, rather it is designed in a Defined Contribution (DC), Contributory Pension Scheme like ours to help people bolster their ultimate Retirement benefits, save more and enjoy some tax savings by doing so. It is a very important component of any successful DC Scheme and should be used for that purpose and nothing else. Anything else would be an abuse and a negation of its purpose.
The truth is that financially astute employees especially those in higher income brackets who otherwise are able to save and invest significant amounts of money in mutual funds or other long-term investment products can and should still do so with their RSAs. If you are a real investor in the make of Benjamin Graham and Warren Buffet, then taking advantage of the tax incentives of VCAs while sitting it out for the long-term is still more advantageous than most other long-term investment products that will not give you the tax protection that VCAs do (and I can prove this with actual calculations). VCAs are still very useful, and still do make a lot of sense for the truly wise, prudent and astute individuals.